A promissory note is a legally binding financial instrument in which one party (the issuer or maker) promises in writing to pay a specific amount of money to another party (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms.
Promissory notes typically include the following key information:
- Principal: This is the amount of money that the issuer is borrowing and promises to repay.
- Maturity Date: This is the date when the issuer must repay the principal amount. Some promissory notes, called “demand notes,” do not have a specific maturity date and instead can be repaid at any time.
- Interest Rate: This is the rate of interest that the issuer must pay on the principal. The interest could be fixed or variable, depending on the terms of the note.
- Issuing Party (Maker) and Paying Party (Payee): The identities of the borrower and lender.
- Repayment Terms: The schedule for repayment (e.g., in installments, as a lump sum at maturity) and what happens if the issuer fails to make a payment.
Promissory notes can be used in many types of transactions, including personal loans between friends or family, business loans, real estate transactions, and more. It is considered a form of credit and is legally enforceable, meaning the payee can go to court to demand payment if the issuer fails to pay as promised.
Example of a Promissory Note
Imagine that Sarah wants to borrow $10,000 from her friend Bob to start a small business. Sarah and Bob agree that Sarah will pay back the money with an annual interest rate of 4% over a period of five years.
To make the agreement official and legally binding, they create a promissory note. The note might read something like this:
Principal Amount: $10,000
Annual Interest Rate: 4%
Date: January 1, 2023
FOR VALUE RECEIVED, I, Sarah (the “Borrower”), promise to pay Bob (the “Lender”), the principal sum of ten thousand dollars ($10,000), together with interest at the rate of four percent (4%) per annum.
Payment Terms: The principal and interest will be repaid in equal annual installments over the next five years, due on the first day of each year.
Borrower’s Signature: ________________
By signing this note, Sarah legally commits to repay Bob according to the terms specified in the note. If she fails to repay the loan as agreed, Bob could potentially take legal action to recover his money.
Please note, this is a very basic example and real-world promissory notes can be much more complex and should be drafted with the assistance of legal counsel to ensure all parties are protected.